After 2022, large real-estate deals driven by US private equity firms became more difficult in Europe, partly due to a sudden paucity of debt funding from investment banks. Smaller deals were sometimes easier as capital continued to flow relatively freely in some continental European banks.
Now, larger investment bank-led financings could be primed for a comeback in parts of the market – even while more traditional real-estate lenders in countries such as Germany and the US are experiencing problems – thanks to greater confidence in the availability of loan-on-loan funding for jumbo deals.
Loan-on-loan funding, in which banks take the senior tranche of a whole loan arranged by a real-estate debt fund, became more important in Europe in the latter part of the last decade, tying into the wider growth in importance of non-bank lenders on the continent.
Now the debt funds are in many cases becoming even more important in this sector relative to banks. The risk-return dynamics of real-estate lending have become far less suited to local commercial lenders, not least as property values are still falling in parts of the market.
Good opportunity
For big US investment banks, as well as larger and more international French and UK banks, the desire to support the growth of these debt funds syncs with the eagerness of their investment banking divisions to foster relationships with large private equity clients – such as Apollo, Ares, KKR or Starwood – not just in real estate, but across their investment-banking businesses.
“We think that there’s a good opportunity for us to service our clients with back leverage,” says Jan Janssen, co-head of real-estate finance for Europe, the Middle East and Africa at Goldman Sachs, speaking about his firm’s desire to grow in loan-on-loan financings in Europe. “For 2024, this should see significant volume.”
We are keen to provide our clients with conviction on the back leverage early to give them a strong position in their whole-loan bid
Jan Janssen, Goldman Sachs
Goldman is not alone. Debt funds appear more assured than they did last year that they will get bids on back leverage, as investment banks have generally become less circumspect in recent months – reflecting the wider upswing in markets, also felt in equities, on the back of a consensus opinion that central bank interest rates have peaked.
“Before rates started to rise, and the Ukraine war, debt funds were willing to underwrite whole loans without certainty on the back leverage,” says Janssen. “As uncertainty grew, debt funds were keen to have back leverage lined up before bidding on the whole loan. While some of that confidence has returned, we are keen to provide our clients with conviction on the back leverage early to give them a strong position in their whole-loan bid.”
Greater availability of loan-on-loan funding in the UK and US, meanwhile, may also reflect what real-estate specialists say is likely to be a more rapid decline and rebound in values in these two countries.
In continental Europe, especially Germany, interest rates were even lower, driving real-estate yields even lower. German banks are also understood to be more reluctant to take up-front losses, likely slowing the German real-estate shake-out.
Commercial real estate financiers in London, by contrast, are already talking of a new meeting of expectations between buyers and sellers – even if office properties remain the most troubled part of the market, thanks to the switch to hybrid working.
Lender finance
Banks are sometimes reluctant to speak openly about their loan-on-loan funding activity, as the client may not be aware that this back leverage is in place. This is in contrast with A-B structures in which the senior lender has more of a direct relationship with the client.
One firm that is relatively willing to talk about its activities in the loan-on-loan market, albeit at the smaller end, is UK neobank OakNorth.
Ben Barbanel, head of debt finance at OakNorth, says what he calls lender finance is a large part of the bank’s financing activities, including loan-on-loan funding.
In late 2022, OakNorth bought a 50% stake in another fintech lending platform called Ask, which allows wealthy investors and institutions to lend to real-estate projects, often providing a mezz portion to top up OakNorth’s senior facility.
It has also provided loan-on-loan funding to other non-bank real-estate lenders, including Hilltop Credit Partners and Lendhub.
There’s a lot of pent-up investor demand that’s now ready to flow
Edward Matthews, Mera Investment Management
Lender finance is attractive, according to Barbanel, as it provides the bank with two sources of equity: that of the underlying borrower and the debt fund.
“It enables us to do different sorts of transactions at different parts of the capital stack, with different partners,” he says. “We see it as a great market, and a great opportunity.
“At the lower end of the market, it enables us to play in lower-sized loans that perhaps we wouldn’t do ourselves because they’re quite management intensive.”
A recent slowdown in the UK housing market has meant fewer opportunities in residential development, previously a mainstay of OakNorth’s lending business. The bank has shifted over the past two years to other forms of real-estate finance, according to Barbanel, including what he calls transition finance – changing a shopping centre to another use class, for example.
Recently, however, Barbanel says residential development financing has also shown some green shoots.
Others in the UK market tell a similar story.
“There’s a lot of pent-up investor demand that’s now ready to flow,” says Edward Matthews, chief executive of real-estate debt and equity-focused Mera Investment Management. “The market is moving this year, and it wasn’t moving much last year. More properties are being bought and sold, and they need funding. There’s more credit available for mid-market lenders and more opportunities to deploy that money.”
